First Financial Bancorp (FFBC) 2007 Q4 法說會逐字稿

Hello, and welcome to the First Financial Bancorp 2007 year-end earnings release. All participants will be in listen-only mode. There will be an opportunity for to you ask questions at the end of today's presentation. An operator will give instructions of how to ask your questions at that time. (OPERATOR INSTRUCTIONS) Please note this conference is being recorded.

Now I would like to turn the conference over to Claude Davis, President and CEO. Sir, you may now begin.

Thank you, Andrea. Before we provide some additional commentary on the fourth-quarter and full-year 2007, Frank Hall, our CFO will read the forward-looking statement.

Thank you, Claude. As we begin, I would like to remind everyone that our discussion today may involve certain forward-looking statements which are not statements of historical fact. The fourth-quarter earnings press release should be read in conjunction with the consolidated financial statements, notes and tables attached in the First Financial Bancorp annual report on form 10-K for the year ended December 31st, 2006. Management's analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties that may cause actual results to differ materially. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited, to the ability of the Company to implement its strategic plan, the strength of the local economies in which operations are conducted, the effects of and changes in policies and laws of regulatory agencies, inflation, and interest rates.

For further discussion of certain factors that may cause such forward-looking statements to differ materially from actual result, refer to the 2006 Form 10-K and other public documents filed with the SEC. These documents are available on the Investor Relations section of our web site, bankatfirst.com and on the SEC's web site at SEC.gov. Additional information will also be provided in our Annual Report on form 10-K for the year ended December 31st, 2007 which will be filed with the SEC by February 29th, 2008. Claude.

Thanks, Frank. We are pleased with our performance this quarter, particularly in a very difficult environment for the banking industry. Our full-year performance is also encouraging, and we believe it is strong evidence that the hard work of our associates in the implementation of our strategic initiatives is producing positive results. When we released third-quarter 2007 results several months ago, I noted that the third quarter had been marked by the continuation of the mortgage-related events that had been primarily limited to the subprime market, but were beginning to have a significant impact on the overall credit and liquidity markets.

That impact accelerated in the fourth quarter, and in response to the disruption, the Federal Reserve began aggressively lowering interest rates, and since September has now reduced the Fed funds rate by a total of 175 basis points. With the impact from the residential mortgage sector rippling through the economy, future economic growth has now also become a concern. However, we believe we are positioned to effectively manage our risk and capitalize on the opportunities that may present themselves in these unique times.

During the fourth quarter, we continue to generate solid Commercial loan growth and our credit quality metrics remain strong. Efficiency and expense control remain strategic initiatives and are contributing in a very positive way to the Company's performance. Developing an effective sales culture, particularly in retail banking continues to be a key to establishing momentum in the growth and production of lower retail product. Our Market Services Group, staffed by associates with experience in increasing sales, growing client relationships, new product development, and increased branch efficiency, has been focusing on the implementation of targeted market, product and customer campaigns. We continue to balance market pricing and growth with a customer's preference for higher yielding money market and time deposits.

The shift in our portfolio mix from Consumer to Commercial loans continues with 17% year-over-year growth in the Commercial, Commercial Real Estate and Construction portfolios. Our metropolitan markets of Cincinnati and Dayton, Ohio, as well as northern Kentucky continue to experience strong loan growth with each exceeding 25% year-over-year growth. Our credit quality metrics remains strong, and are but one of the benefits from the decision to shift from consumer-based lend to more commercial focus. We remain optimistic that even in this stressful environment for both commercial and consumer borrowers, the decision to reduce our exposure to the residential mortgage and indirect auto loan sectors, combined with disciplined processes regarding land development and construction lending, we will effectively manage our credit risks.

We experienced a low level of net charge-offs for the year and have maintained relatively stable levels of nonperforming and classified assets. We are now providing in a credit quality schedule our total classified assets for the past five quarters. In addition to nonperforming loans, this category includes loans that are still performing but may have characteristics that warrant a heightened level of attention. There are no particular concentration in our total classified assets. The ratio of nonperforming loans to total loans was 56 basis points at year end, up slightly from 53 basis points at the end of the third quarter, and our allowance for loan losses to total loans ratio remained level with the third quarter at 1.12%.

First Financial continues to work diligently to stay ahead of credit quality issues not only by enhancing our processes and procedures, but by being aggressive in the workout of problem credits. Continued economic weaknesses could produce elevated credit costs in future quarters, but we are focused on aggressively managing the areas of potential weakness. In 2007, we experienced year-over-year growth of 10% in our home equity portfolio. Our underwriting criteria are rigid and we monitor the portfolio by a number of metrics, including credit scores, loan to value ratios, line size and usage. More than 60% of the portfolio has a FICO score greater than 740.

During the fourth quarter, we did experience increased nonaccrual loans in our home equity and residential mortgage portfolios, consistent with the industry and weakness in the consumer sector. First Financial does not have a concentration of commercial loans to home developers with a portfolio of approximately $47 million. We limit our exposure from both a development and speculum activities in any particular project by having strong internal policies requiring an extensive underwriting process, including providing multiple sources of repayment, however, a protracted economic recession could cause some of our clients in this area to experience difficulties.

Frank Hall, our Chief Financial Officer will now review the highlights of the other areas of our full-year and fourth-quarter performance. Frank.

Thank you, Claude. There are a number specific items that I would like to highlight in our fourth-quarter results of $0.29 per share. There were also some events from the quarter that will impact our performance going forward, and I will make some comments regarding those events in the context of our outlook for 2008. First Financial will not provide earnings guidance for 2008. We will, however, offer high-level and directional guidance on certain key categories. In 2007, we offered guidance to provide some baseline given that there was a significant amount of change in 2006. Now that a baseline has been established, this will be our approach for future periods.

Net income for the quarter was impacted by several unusual items which include a $5.5 million gain on the sale of the merchant processing portfolio, a $2.2 million pension settlement charges, and $0.5 million charge associated with Visa litigation. These events total approximately $0.05 a share. The net interest margin for the fourth quarter of 2007 was 3.79% on a nontax equivalent basis, down from 3.88% in the third quarter. The positive impact from our continuing shift in asset mix was more than offset by the effects of multiple reductions in the Fed funds rate which affected our prime base and variable rate portfolios. Near term, net interest income will be impacted mostly by market interest rate decreases and how well we manage our interest-sensitive deposits, while balancing the market level pricing of our competitors, client growth goals, and our retention objectives. Liquidity is a lesser concern as our current loan-to-deposit ratio remains at approximately 90%.

While our 2007 margin was within the full-year and fourth-quarter guidance ranges, when rate changes occur, there is a greater near-term effect on net interest income with a slow recovery to previous levels. The rate cuts thus far are significant enough that our expected 2008 quarterly and full-year margins will not return to pre-rate cut levels experienced in 2007 until some time after the next 12 months. The risk in any model, however, is the unknown effect of customer behavior, the effects of further rate cuts, and the ability to match liability rate moves to asset rate moves in this decreasing rate environment. Additionally, we are evaluating wholesale and account level strategies to mitigate the effects of these cuts. It is premature to estimate the full-year 2008 margin as we expect our balance sheet characteristics to change as we deploy these strategies.

Loan growth continues in the Commercial and Commercial real estate sectors. This is a consistent point of emphasis as we shift our asset mix from a consumer heavyweighting to one of Commercial. Deposits on an average basis have remained stable over the reporting periods with a primary focus on new transaction deposits and retention. We continue to deal with the impact of price and account migration to higher cost money market accounts. This period in particular, however, we have seen market pricing that is well outside our range of profitability. These competitor rates could have a short-term effect on both our retention of existing balances and our expected margin on the deposit portfolio. Regional pricing seems to be driven more by liquidity pressure, rather than maintaining a positive spread to Fed funds, and we will not chase irrational pricing, especially given our liquidity position and our alternative sources of wholesale funding.

Linked quarter non-interest income excluding the effect of the $5.5 million gain on sale of the merchant portfolio increased primarily due to higher trust and wealth management fees. Trust fees increased for the quarter due to both a mixed shift in the account types to higher fee products and some market value increases in certain holdings. Non-interest expense in 2007 declined significantly when compared to 2006 due to our successful implementation of our strategic plan which occurred throughout 2006.

Excluding costs associated with executing the plan and other items that are expected not to reoccur, total non-interest expense has declined approximately 15% on a year-over-year basis. Excluding the effect of the pension settlement charge, linked quarter non-interest expense was relatively flat. Expense control remains one of our priority items this year with planned, though modest, expense cuts expected in 2008. Credit quality remains a bright spot in our performance with an annualized net charge-off level for the quarter of 26 basis points and 24 basis points for the year.

As Claude mentioned earlier, though we are pleased with our historic credit quality results and our processes, we are mindful of the possibilities of unforeseen credit events, the risk of these events is elevated in difficult economic times and is addressed in our allowance for loan loss model. As of year-end 2007, we believe our allowance coverage to nonperforming loans and nonaccrual loans of 206% and 198% respectively is adequate. Capital remains strong. During the fourth quarter, First Financial did not repurchase any shares and does not expect to repurchase any additional shares in 2008.

In conclusion, we knew 2007 would be a challenging year for First Financial, and we feel that we have finished strong. We believe that we have executed well on many of our goals and objectives this year such as solid credit quality, commercial loan growth, and expense reduction. Maintaining the net interest margin at our historic levels has been challenging, primarily due to slower deposit growth and pricing pressure. The headwinds of further rate cuts and broad economic downturn will provide new challenges for 2008.

We appreciate your interest in our company and this concludes the prepared comments section of the call. We will now open up the call for questions. Andrea.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Scott Siefers of Sandler O'Neill. Please, go ahead.

Good morning, guys.

Hi, Scott.

A couple of questions on a couple of different topics. First on the margin, I mean, I guess given the surprise rate cut last week and then -- I guess the likelihood of an additional cut this afternoon, would it be correct to assume that the margin decline would accelerate, or are there items in place that would -- would start to mitigate some of the additional margin compression?

Scott, this is Frank. I think it's fair to say that the rate cuts will have a negative effect on the margin, and as I said in the prepared comments, it is a skewed effect to the -- to the earlier portion of the year. The degree of change we haven't disclosed and are still working through, as I said, several wholesale and account level strategies to mitigate that risk.

Okay. And then, let's see, jumping to difference in the guidance. I guess on fee income, you say modest fee income growth. What are the main drivers of that? And I guess, probably more importantly, what is kind of the base dollar value of fee income that you are forecasting off of? Just that there were some unusual items in the '07 number.

Yes, the baseline for -- for those comments is full-year '07.

Okay. All right. So the stated -- the stated fee income number though -- or does that exclude some of the unusual items?

Excluding the unusual items.

Oh, okay.

Which have been -- we will have to go back and look at each of the quarters, but -- for instance, the $5.5 million gain --

Yes.

-- next year, that would be excluded.

Okay. All right. Then I guess just on credits and such, I mean, obviously pretty good quarter here, and it sounds like you are, I guess, cautiously optimistic about 2008. I guess on the Commercial Real Estate portfolio and specifically the combination of the roughly $91 million in CRE construction and then the additional 40 odd million in residential construction, and some of the, I guess, prereleases and higher reserve builds, et cetera that we saw this quarter were driven by kind of deep dives into those portfolios that resulted in some -- some markdowns. Have you guys conducted any similar kind of more recent appraisals? Things of that nature? Taking a special look at those portfolios?

Yes, Scott, this is Claude. We are, as you can imagine, and consistent with others, we are aggressively managing the -- the construction and real estate portions of our Commercial portfolio and specifically as an example in the residential development portfolio, really having frequent conversations with those developers to understand what lot sales are doing and when appropriate, doing revaluations, as well as making sure that they have taken proactive steps to kind of manage through this this, whether that be injecting additional cash, in some cases we have asked ourselves for additional cash reserves. So we are aggressively managing that portfolio. And feel like it is reflected appropriately in the reserve and the -- and the other metrics that we have published.

Okay. And then -- let's see. In 2008, is it a fair assumption to think that you guy will probably kind of -- at least match the provision in charge-offs? Just given where we are in the credit cycle.

I would just comment that the allowance model is something that we evaluate each quarter. The 30 to 40 basis points expected net charge-offs is about the best guidance that we can give there. Other risk characteristics come into play as we look at the model itself, and that is really going to drive what the provision expense is.

Okay. Back on CRE for just a second. We have seen, industry-wide, the obvious turn on the -- the construction and residential side. Are you guys seeing any weakness spreading into other areas, retail, office, you name it within the CRE portfolio?

Yes, Scott. We have not yet seen a significant impact on the nonresidential commercial real estate projects at this point. Most of our borrowers in that area have not shown the same challenges or weaknesses that the residential side has demonstrated. So, at this point, no. It is obviously something we are watching very closely and concerned about, should a recession either deepen or occur, depending on your perspective, but, yes, we are very sensitive and watching that very closely, but to this point, no.

Okay. Sounds good. Thank you very much.

Thanks, Scott.

Thanks

Thank you. Our next question comes from Christopher McGratty of KBW. Please go ahead.

Good morning. A quick question on the deposit -- on the deposit balances. Correct me if I'm wrong, but there is some seasonality with the public funds business that you discussed in the past. Can you just remind me exactly what the ebbs and flows were this quarter? And then how I should think of that with respect to the margins?

Chris, I am having a hard time hearing you, this is Frank. I think your question is about the seasonality in deposits.

Right.

But if you're looking at the period-end deposit balance for the fourth quarter, that was driven by a very large deposit from a commercial deposit account. So that -- that's what is skewing the numbers. I think what you will see last quarter, we had a large public fund. The seasonality on that, I believe, is in the first and third quarter.

Really, early spring, late fall, its around tax collections, Chris, that caused that.

Okay. So, I guess, in terms of next quarter, we should see some of these balances, I guess, flow out of the bank?

As far as the --

The non-interest bearing, despite the quarter.

Well, not as much average as it is on the period end.

That's right.

Okay. Thanks.

Chris, one other just comment on that. There is some year-end seasonality. I think most banks see some year-end seasonality around -- especially the transaction level deposits, where they tend to be somewhat higher in the fourth quarter and the low point on many of those is typically the first quarter, with it billed back through the year just on our normal commercial account, somewhat on the personal side, but more commercial oriented.

Okay. I guess I had one more question, if you don't mind, on the watch list trends. Can you maybe make a couple of comments on what you are seeing there?

We did include --

Maybe I missed it.

-- in this quarter in the credit quality schedule, the classified assets totals to try to help with an indicator there. And as you can see Chris, on the classified assets, we have been pretty flat throughout 2007, and we -- we -- that's generally what we have been seeing, and that has been the positive part for us is really to credit quality management. As we tried to comment both in the release and in our prepared comments, we are very diligent on that issue, because with the economy we are concerned and watching it closely. But to this point our classified assets have not seen a material increase. They have been actually flat.

Thank you.

(OPERATOR INSTRUCTIONS) Sir, at this time, we have no further questions.

All right. Andrea, thank you. And thanks, everyone, for joining our call and the interest First Financial. Thank you.